Professional Documents
Culture Documents
CHAPTER OVERVIEW
2. OBJECTIVES OF AUDIT
As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit
of financial statements, the overall objectives of the auditor are:
(a) To obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement ; and
(b) To report on the financial statements, and communicate as required by the SAs,
in accordance with the auditor’s findings.
3. SCOPE OF AUDIT
The following points merit consideration in regard to scope of audit :
1. The audit should be organized to cover adequately all aspects of the enterprise
relevant to the financial statements being audited.
2. To form an opinion on the financial statements, the auditor should be reasonably
satisfied as to whether the information contained in the underlying accounting
records and other source data is reliable and sufficient as the basis for the
preparation of the financial statements.
3. In forming his opinion, the auditor should also decide whether the relevant
information is properly disclosed in the financial statements subject to
statutory requirements, where applicable.
4. The auditor assesses the reliability and sufficiency of the information
contained in the underlying accounting records and other source data by:
(a) making a study and evaluation of accounting systems and internal
controls and
(b) carrying out such other tests, enquiries and other verification procedures of
accounting transactions and account balances as he considers appropriate in
the particular circumstances.
5. The auditor determines whether the relevant information is properly
disclosed in the financial statements by:
(a) comparing the financial statements with the underlying accounting
records and other source data to see whether they properly summarize the
transactions and events recorded therein; and
(ii) Reviewing the system and procedures to find out whether they are adequate and
comprehensive and incidentally whether material inadequacies and weaknesses
exist to allow frauds and errors going unnoticed.
(iii) Checking of the arithmetical accuracy of the books of account by the
verification of postings, balances, etc.
(iv) Verification of the authenticity and validity of transaction entered into by
making an examination of the entries in the books of accounts with the relevant
supporting documents.
(v) Ascertaining that a proper distinction has been made between items of
capital and of revenue nature and that the amounts of various items of income
and expenditure adjusted in the accounts corresponding to the accounting
period.
(vi) Comparison of the balance sheet and profit and loss account or other
statements with the underlying record in order to see that they are in
accordance therewith.
(vii) Verification of the title, existence and value of the assets appearing in the
balance sheet.
4. TYPES OF AUDIT
Audit is not legally obligatory for all types of business organisations or institutions.
On this basis audits may be of two broad categories i.e., audit required under law
and voluntary audits.
(i) Audit required under law: The organisations which require audit under law
are the following: e.g companies governed by the Companies Act; banking
companies; other statutory bodies required by their regulators or by specific Act.
(ii) In the voluntary category are the audits of the accounts of proprietary entities,
partnership firms, Hindu undivided families, etc. In respect of such accounts, there
is no basic legal requirement of audit. Many of such enterprises as a matter of
internal rules require audit. Some may be required to get their accounts audited
on the directives of Government for various purposes like sanction of grants,
loans, etc. But the important motive for getting accounts audited lies in the
advantages that follow from an independent professional audit. This is perhaps
the reason why large numbers of proprietary and partnership business get their
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NATURE, OBJECTIVE AND SCOPE OF AUDIT 1.7
accounts audited. Government companies have some special features which will
be seen later.
As already stated, the auditor should get the scope of his duties and responsibilities
defined by obtaining instructions in writing. Also it is always a wise precaution to
state in the report, accompanying the balance sheets of proprietary or partnership
firms or other similar organisations, the nature of the work carried out and explain
the important features of the financial statements on which a report has been made.
Furthermore, to ensure that the report will be brought to the notice of all concerned,
the accounts should bear reference to the report.
A special reference is necessary for non-profit making institutions like schools, clubs,
hospitals. Most of these have some internal rules to govern their affairs and generally
a provision about the requirement of audit is inserted. Activity in the nature of business
is not altogether ruled out as a club may sell drinks and eatables to the members and
their guests or a school may have endowed agricultural property to yield income.
What makes them distinct, is the absence of the question of division of profit: any
surplus which may arise can only be used for achieving the objects of the institution.
Educational institutions, hospitals, associations, etc., irrespective of any internal rules,
get their accounts audited because most of them enjoy government or municipal
grants and, generally, for this purpose audited accounts are insisted upon.
Trust, however, stands on a slightly different footing; these may be public trusts or
private trusts. Trusts can carry on business as well. In the majority of cases trustees are
private persons. Trusts generally have two classes of beneficiaries; tenants for life and
remainders; persons to whom the accounts are of the supreme importance are often
widows and minors, who cannot criticize the accounts in any effective manner. Though
audit of trusts, except for public trusts, is not compulsory most of the trust deeds
contain a clause for audit of accounts. Private trustees also recognise the advantages
of audit in their own interest, since any erroneous treatment in the accounts for which
they might be personally liable will be pointed out by the auditor.
(c) Audited statements of account are helpful in settling liability for taxes,
negotiating loans and for determining the purchase consideration for a business.
(d) These are also useful for settling trade disputes for higher wages or bonus as
well as claims in respect of damage suffered by property, by fire or some other
calamity.
(e) An audit can also help in the detection of wastages and losses to show the
different ways by which these might be checked, especially those that occur due
to the absence or inadequacy of internal checks or internal control measures.
(f) Audit ascertains whether the necessary books of account and allied records
have been properly kept and helps the client in making good deficiencies or
inadequacies in this respect.
(g) As an appraisal function, audit reviews the existence and operations of
various controls in the organisations and reports weaknesses, inadequacies,
etc., in them.
(h) Audited accounts are of great help in the settlement of accounts at the time of
admission or death of partner.
(i) Government may require audited and certified statement before it gives
assistance or issues a license for a particular trade.
(iv) Other Matters that Affect the Limitations of an Audit: In the case of certain
subject matters, limitations on the auditor’s ability to detect material misstatements
are particularly significant. Such assertions or subject matters include:
— Fraud, particularly fraud involving senior management or collusion.
— The existence and completeness of related party relationships and transactions.
— The occurrence of non-compliance with laws and regulations.
— Future events or conditions that may cause an entity to cease to continue as
a going concern.
ILLUSTRATION
MNO Ltd requested the auditor CA P to provide for absolute assurance in respect of its
ten branches scattered in Delhi and confirm that the financial statements are free from
material misstatement due to fraud or error. Advise.
SOLUTION
The auditor is not expected to, and cannot, reduce audit risk to zero and cannot
therefore obtain absolute assurance that the financial statements are free from material
misstatement due to fraud or error. This is because there are inherent limitations of an
audit, which result in most of the audit evidence on which the auditor draws conclusions
and bases the auditor’s opinion being persuasive rather than conclusive.
In view of the above, CA P cannot provide audit absolute assurance to MNO Ltd in
respect of its branches.
Timeliness of Financial Reporting and the Balance between Benefit and Cost:
Relevance of information, and thereby its value, tends to diminish over time, and
there is a balance to be struck between the reliability of information and its cost.
Other Matters that Affect the Limitations of an Audit: Certain assertions or subject
matters are particularly significant, such assertions or subject matters include:
Fraud, particularly involving senior The occurrence of non-compliance
management or collusion. with laws and regulations.
The existence and completeness Future events or conditions that may
of related party relationships and cause an entity to cease to continue
transactions. as a going concern.
ILLUSTRATION
DEF & Co. Chartered Accountants successfully carried out the audit of Shree Garments
for the f.y. 2015-2016. After the completion of the audit, there were found material
misstatements due to fraud in the financial statements which were not noticed and
reported by the auditor. Management alleges that it is failure on the part of auditor.
Comment.
SOLUTION
Because of the limitations of an audit, there is an unavoidable risk that some material
misstatements of the financial statements may not be detected, even though the audit
is properly planned and performed in accordance with SAs. Accordingly, the subsequent
discovery of a material misstatement of the financial statements resulting from fraud
or error does not by itself indicate a failure to conduct an audit in accordance with SAs.
However, the inherent limitations of an audit are not a justification for the auditor to be
satisfied with less-than-persuasive audit evidence. Whether the auditor has performed
an audit in accordance with SAs is determined by the audit procedures performed in
the circumstances, the sufficiency and appropriateness of the audit evidence obtained
as a result thereof and the suitability of the auditor’s report based on an evaluation of
that evidence in light of the overall objectives of the auditor.
discipline of statistics has come quite close to auditing as the auditor is also expected
to have the knowledge of statistical sampling so as to arrive at meaningful conclusions.
The knowledge of mathematics is also required on the part of auditor particularly at
the time of verification of inventories. The use of data analytics is advancing rapidly
in auditing where many organizations are using continuous auditing and continuous
monitoring of data to identify risks as part of their system of internal control.
7.6 Auditing and Data Processing
Today, organisations are witnessing revolution in the field of data processing of accounts.
Many organisations are carrying out their financial accounting activities with the help
of computers which can document, record, collate, allocate and value accounting
data and information in very large quantity at very high speed. The dependence on
the accuracy of the programmed instructions given today, the computer is able to
carry out each of these activities with complete accuracy. With such a phenomenal
growth in the field of computer sciences, the auditor should have good knowledge
of the components, general capability of the system and the related terms. In fact,
Computerised Information System auditing in itself is developing as a discipline in
itself.
7.7 Auditing and Financial Management
Auditing is also closely related with other functional fields of business such as finance,
production, marketing, personnel and other general areas of business management.
With the overgrowing field of auditing, the financial services sector occupies a
dominant place in our system. While in general terms, the auditor is expected to have
knowledge about various financial techniques such as working capital management,
funds flow, ratio analysis, capital budgeting etc. The auditor is also expected to have
a fair knowledge of the institutions that comprise the market place. The knowledge
of various institutions and Government activities that influence the operations of the
financial market are also required to be understood by an auditor.
7.8 Auditing and Production
Regarding production function, it may be stated that a good auditor is one who
understands the client and his business. While carrying out the audit activity, the
auditor is required to evaluate transactions from the accounting aspect in relation to
the process through which it has passed through as accounting for by-products; joint-
products may also require to be done. The knowledge of production process shall
become more essential in case of an internal auditor. The auditor shall also require
understanding the cost system in operation in the factory and assessing whether the
same is adequate for the particular company. The understanding of the terminology of
the production shall enable an auditor to communicate with production employees in
connection with his work.
On the similar pattern the auditor is also expected to have good understanding about
the marketing, personnel and other general business management areas.
These Standards will apply whenever an independent audit is carried out; that is, in the
independent examination of financial information of any entity, whether profit oriented
or not, and irrespective of its size, or legal form (unless specified otherwise) when such
an examination is conducted with a view to expressing an opinion thereon.
While discharging their attest function, it will be the duty of members of the Institute to
ensure that the Standards are followed in the audit of financial information covered by
their audit reports. If for any reason a member has not been able to perform an audit
in accordance with the Standards, his report should draw attention to the material
departures therefrom, auditors will be expected to follow Standards in the audits
commencing on or after the date specified in the statement. Remember all Standards
are mandatory from the date mentioned herein and it is obligatory upon members of
Institute to adhere to these whenever an audit is carried out.
All relevant Standards which are important from students’ view point have been
covered as an integral part of the text.
Compliance with Documents Issued by the Institute: The Institute has, from time
to time, issued ‘Guidance Notes’ and ‘Statements’ on a number of matters. The
‘Statements’ have been issued with a view to securing compliance by members on
matters which, in the opinion of the Council, are critical for the proper discharge of
their functions. ‘Statements’ therefore are mandatory.
Accordingly, while discharging their attest function, it will be the duty of the members
of the Institute:
(a) to examine whether ‘Statements’ relating to accounting matters are complied
with in the presentation of financial statements covered by their audit. In
the event of any deviation from the ‘Statements’, it will be their duty to make
adequate disclosures in their audit reports so that the users of financial
statements may be aware of such deviations; and
(b) to ensure that the ‘Statements’ relating to auditing matters are followed in
the audit of financial information covered by their audit reports. If, for any
reason, a member has not been able to perform an audit in accordance with
such ‘Statements’, his report should draw attention to the material departures,
therefrom.
‘Guidance Notes’ : are primarily designed to provide guidance to members on matters
which may arise in the course of their professional work and on which they may rely
in the course of their professional work and on which they may desire assistance in
resolving issues which may pose difficulty. Guidance Notes are recommendatory in
nature. A member should ordinarily follow recommendations in a guidance note
relating to an auditing matter except where he is satisfied that in the circumstances
of the case, it may not be necessary to do so. Similarly, while discharging his attest
function, a member should examine whether the recommendations in a guidance note
relating to an accounting matter have been followed or not. If the same have not been
followed, the member should consider whether keeping in view the circumstances of
the case, a disclosure in his report is necessary.
There are however a few guidance notes in case of which the Council has specifically
stated (discussed in Announcements part reproduced in Handbook on Auditing
Pronouncements) that they should be considered as mandatory on members while
discharging their attest function.
9. QUALITIES OF AN AUDITOR
It is not enough to realise what an auditor should be. He is concerned with the reporting
on financial matters of business and other institutions. Financial matters inherently
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NATURE, OBJECTIVE AND SCOPE OF AUDIT 1.19
are to be set with the problems of human fallibility; errors and frauds are frequent.
The qualities required, according to Dicksee, are tact, caution, firmness, good temper,
integrity, discretion, industry, judgement, patience, clear headedness and reliability. In
short, all those personal qualities that go to make a good businessman contribute to
the making of a good auditor. In addition, he must have the shine of culture for attaining
a great height. He must have the highest degree of integrity backed by adequate
independence. In fact, Code of ethics mentions integrity, objectivity and independence
as one of the fundamental principles of professional ethics.
He must have a thorough knowledge of the general principles of law which govern
matters with which he is likely to be in intimate contact. The Companies Act need
special mention but mercantile law, specially the law relating to contracts, is no less
important. Needless to say, where undertakings are governed by a special statute, its
knowledge will be imperative; in addition, a sound knowledge of the law and practice
of taxation is unavoidable.
He must pursue an intensive programme of theoretical education in subjects like
financial and management accounting, general management, business and corporate
laws, computers and information systems, taxation, economics, etc. Both practical
training and theoretical education are equally necessary for the development of
professional competence of an auditor for undertaking any kind of audit assignment.
The auditor should be equipped not only with a sufficient knowledge of the way in
which business generally is conducted but also with an understanding of the special
features peculiar to a particular business whose accounts are under audit. The auditor,
who holds a position of trust, must have the basic human qualities apart from the
technical requirement of professional training and education.
He is called upon constantly to critically review financial statements and it is obviously
useless for him to attempt that task unless his own knowledge is that of an expert. An
exhaustive knowledge of accounting in all its branches is the sine qua non of the practice
of auditing. He must know thoroughly all accounting principles and techniques.
Lord Justice Lindley in the course of the judgment in the famous London & General
Bank case had succinctly summed up the overall view of what an auditor should be
as regards the personal qualities. He said, “an auditor must be honest that is, he must
not certify what he does not believe to be true and must take reasonable care and skill
before he believes that what he certifies is true”.
The auditor should be independent of the entity subject to the audit. The Code
describes independence as comprising both-
Independence of Mind
and
Independence in Appearance.
The auditor’s independence safeguards the auditor’s ability to form an audit opinion
without being affected by any influences. Independence enhances the auditor’s
ability to act with integrity, to be objective and to maintain an attitude of professional
skepticism.
Standard on Quality Control (SQC) 1 sets out the responsibilities of the firm for
establishing policies and procedures regarding compliance with relevant ethical
requirements.
SA 220 sets out the engagement partner’s responsibilities with respect to relevant
ethical requirements. These include evaluating whether members of the engagement
team have complied with relevant ethical requirements. SA 220 recognises that the
engagement team is entitled to rely on a firm’s systems in meeting its responsibilities
with respect to quality control procedures.
10.2.1 Independence of Auditors
Professional integrity and independence are considered essential characteristics of all
the professions but are more so in the case of accountancy profession. Independence
implies that the judgement of a person is not subordinate to the wishes or direction of
another person who might have engaged him.
It is not possible to define “independence” precisely. Rules of professional conduct
dealing with independence are framed primarily with a certain objective. The rules
themselves cannot create or ensure the existence of independence. Independence is
a condition of mind as well as personal character. It should not be confused with the
superficial and visible standards of independence which are sometimes imposed by
law.
There are two interlinked perspectives of independence of auditors, one, independence
of mind; and two, independence in appearance. The Code of Ethics for Professional
Accountants issued by International Federation of Accountants (IFAC) defines the term
‘Independence’ as follows:
“Independence is: (a) Independence of mind – the state of mind that permits the
provision of an opinion without being affected by influences allowing an individual to
act with integrity, and exercise objectivity and professional skepticism; and
(b) Independence in appearance – the avoidance of facts and circumstances that
are so significant that a third party would reasonably conclude an auditor’s integrity,
objectivity or professional skepticism had been compromised.”
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1.22 AUDITING AND ASSURANCE
Independence of the auditor has not only to exist in fact, but also appear to so
exist to all reasonable persons.
The objective of an audit of financial statements is to enable an auditor to express an
opinion on such financial statements. The auditor’s opinion helps determination of
the true and fair view of the financial position and operating results of an enterprise.
The user should not assume that the auditor’s opinion is an assurance as to the future
viability of the enterprise or the efficiency or effectiveness with which management has
conducted the affairs of the enterprise.
The auditor should be straightforward, honest and sincere in his approach to his
professional work. He must be fair and must not allow prejudice or bias to override
his objectivity. He should maintain an impartial attitude and both be and appear to be
free of any interest which might be regarded as being incompatible with integrity and
objectivity.
Many different circumstances, or combination of circumstances, may be relevant
and accordingly it is impossible to define every situation that creates threats to
independence and specify the appropriate mitigating action that should be taken. In
addition, the nature of assurance engagements may differ and consequently different
threats may exist requiring the application of different safeguards.
10.2.2 Threats to Independence
The Code of Ethics for Professional Accountants, prepared by the International
Federation of Accountants (IFAC) identifies five types of threats. These are:
1. Self-interest threats, which occur when an auditing firm, its partner or associate
could benefit from a financial interest in an audit client. Examples include (i) direct
financial interest or materially significant indirect financial interest in a client, (ii)
loan or guarantee to or from the concerned client, (iii) undue dependence on a
client’s fees and, hence, concerns about losing the engagement, (iv) close business
relationship with an audit client, (v) potential employment with the client, and (vi)
contingent fees for the audit engagement.
2. Self-review threats, which occur when during a review of any judgement or
conclusion reached in a previous audit or non-audit engagement (Non audit
services include any professional services provided to an entity by an auditor,
other than audit or review of the financial statements. These include management
services, internal audit, investment advisory service, design and implementation
of information technology systems etc.), or when a member of the audit team
was previously a director or senior employee of the client. Instances where such
threats come into play are (i) when an auditor having recently been a director or
senior officer of the company, and (ii) when auditors perform services that are
themselves subject matters of audit.
3. Advocacy threats, which occur when the auditor promotes, or is perceived to
promote, a client’s opinion to a point where people may believe that objectivity is
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NATURE, OBJECTIVE AND SCOPE OF AUDIT 1.23
getting compromised, e.g. when an auditor deals with shares or securities of the
audited company, or becomes the client’s advocate in litigation and third party
disputes.
4. Familiarity threats are self-evident, and occur when auditors form relationships
with the client where they end up being too sympathetic to the client’s interests.
This can occur in many ways: (i) close relative of the audit team working in a
senior position in the client company, (ii) former partner of the audit firm being
a director or senior employee of the client, (iii) long association between specific
auditors and their specific client counterparts, and (iv) acceptance of significant
gifts or hospitality from the client company, its directors or employees.
5. Intimidation threats, which occur when auditors are deterred from acting
objectively with an adequate degree of professional skepticism. Basically, these
could happen because of threat of replacement over disagreements with the
application of accounting principles, or pressure to disproportionately reduce
work in response to reduced audit fees.
10.2.3 Safeguards to Independence
The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats.
The following are the guiding principles in this regard: -
1. For the public to have confidence in the quality of audit, it is essential that auditors
should always be and appears to be independent of the entities that they are
auditing.
2. In the case of audit, the key fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be independent.
3. Before taking on any work, an auditor must conscientiously consider whether it
involves threats to his independence.
4. When such threats exist, the auditor should either desist from the task or put in
place safeguards that eliminate them.
5. If the auditor is unable to fully implement credible and adequate safeguards, then
he must not accept the work.
10.2.4 Professional Skepticism
Information that brings into question the reliability of documents and responses
to inquiries to be used as audit evidence.
Circumstances that suggest the need for audit procedures in addition to those
required by the SAs.
The integrity of the principal owners, key management and those charged with
governance of the entity;
Whether the firm and the engagement team can comply with relevant ethical
requirements; and
Significant matters that have arisen during the current or previous audit
engagement, and their implications for continuing the relationship.
If the engagement partner obtains information that would have caused the firm
to decline the audit engagement had that information been available earlier, the
engagement partner shall communicate that information promptly to the firm, so that
the firm and the engagement partner can take the necessary action.
10.4 Human Resources
The firm should establish policies and procedures designed to provide it with
reasonable assurance that it has sufficient personnel with the capabilities, competence,
and commitment to ethical principles necessary to perform its engagements in
accordance with professional standards and regulatory and legal requirements, and
to enable the firm or engagement partners to issue reports that are appropriate in the
circumstances.
Such policies and procedures address the following personnel issues:
(a) Recruitment;
(b) Performance evaluation;
(c) Capabilities;
(d) Competence;
(e) Career development;
(f) Promotion;
(g) Compensation; and
(h) Estimation of personnel needs.
Addressing these issues enables the firm to ascertain the number and characteristics
of the individuals required for the firm’s engagements. The firm’s recruitment processes
include procedures that help the firm select individuals of integrity as well as the
capacity to develop the capabilities and competence necessary to perform the firm’s
work.
10.5 Engagement Performance
The firm should establish policies and procedures designed to provide it with
reasonable assurance that engagements are performed in accordance with professional
standards and regulatory and legal requirements, and that the firm or the engagement
partner issues reports that are appropriate in the circumstances.
Through its policies and procedures, the firm seeks to establish consistency in the
quality of engagement performance. This is often accomplished through written or
electronic manuals, software tools or other forms of standardized documentation,
and industry or subject matter-specific guidance materials. Matters addressed include
the following:
Methods of reviewing the work performed, the significant judgments made and
the form of report being issued.
Appropriate documentation of the work performed and of the timing and extent
of the review.
(b) Whether the quality control system has been appropriately designed and
effectively implemented; and
(c) Whether the firm’s quality control policies and procedures have been appropriately
applied, so that reports that are issued by the firm or engagement partners are
appropriate in the circumstances.
Follow-up by appropriate firm personnel so that necessary modifications are promptly
made to the quality control policies and procedures.
In order to establish whether the preconditions for an audit are present, the auditor
shall:
(a) Determine whether the financial reporting framework is acceptable; and
(b) Obtain the agreement of management that it acknowledges and understands its
responsibility:
(i) For the preparation of the financial statements in accordance with the
applicable financial reporting framework;
(ii) For the internal control as management considers necessary; and
(iii) To provide the auditor with:
Access to all information such as records, documentation and other
matters;
Additional information that the auditor may request from management
for the purpose of the audit; and
Unrestricted access to persons within the entity from whom the auditor
determines it necessary to obtain audit evidence.
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1.28 AUDITING AND ASSURANCE
The auditor may decide not to send a new audit engagement letter or other written
agreement each period. However, the following factors may make it appropriate to
revise the terms of the audit engagement or to remind the entity of existing terms:
Any indication that the entity misunderstands the objective and scope of the
audit.
Analysis
— If management or TCWG
— impose limitation on the scope
— such that auditor believes
— limitation would result in
— auditor disclaiming an opinion
— the auditor shall not accept such a limited engagement
The auditor would consider carefully the reason given for the request, particularly
the implications of a restriction on the scope of the engagement, especially any legal
or contractual implications.
of work performed; the work performed supports the conclusions reached and is
appropriately documented; the evidence obtained is sufficient and appropriate to
support the auditor’s report; and the objectives of the engagement procedures have
been achieved.
Further, one of the basic principles, which govern the auditor’s professional
responsibilities and which should be complied with wherever an audit is carried, is that
when the auditor delegates work to assistants or uses work performed by other auditor
and experts, he will continue to be responsible for forming and expressing his opinion
on the financial information. However, he will be entitled to rely on work performed by
others, provided he exercises adequate skill and care and is not aware of any reason
to believe that he should not have so relied. This is the fundamental principle which is
ethically required as per Code of Ethics.
However, the auditor should carefully direct, supervise and review work delegated. He
should obtain reasonable assurance that work performed by other auditors/experts
and assistants is adequate for his purpose.
In the given case, all the auditing procedures before the moment of signing of final
report have been performed by CA. Suresh. However, the report could not be signed
by him due to his unfortunate death. Later on, CA. Chandra signed the report relying
on the work performed by CA. Suresh. Here, CA. Chandra is allowed to sign the audit
report, though, will be responsible for expressing the opinion. He may rely on the work
performed by CA. Suresh provided he further exercises adequate skill and due care and
review the work performed by him.
CASE STUDY
Mr. Veeru of Delhi has started a new business of selling of Handloom items. He
purchases these items from a factory situated in Ludhiana and sells to local customers
at a price which gives him reasonable amount of profit. All gets well in the first year and
he earns some income from the business.
However, he feels that he could expand this business if he was able to bring more items
to the place where he sells them and also he is aware of the fact that there are several
other locations as well where he could sell these items. He could achieve this by buying
a van and by employing other people who will assist him in his business on the other
locations.
He needs more money to achieve this expansion of his business. He decides to ask his
friend Raju to invest in the business.
Having seen the potential of Veeru’s business, Raju wants to invest, but neither he
wants to manage nor wants to have ultimate liability for the debts of the business in
case business fails. He therefore suggested that they should set up a proprietary firm.
He will be the owner of the firm and will be entitled to profits. On the other hand, Veeru
would be the Manager and be paid a salary.
At the end of the first year of trading when Raju receives copy of the financial statements,
he finds that Profits are much lower than what was expected. Raju knows that Veeru is
paid salary so he may not care for low profits. Raju is concerned by the level of profits
and feels that he wants further assurance on the accounts. He does not know whether
the accounts give a true and fair view of the last year’s trading because the profits do
not seem as high as those Veeru had predicted when he agreed to invest.
Raju seeks solution for his problem.
The solution is that the assurance Raju is seeking may be given by an Independent
Audit of accounts.
SUMMARY
An audit is independent examination of financial information of any entity, whether
profit oriented or not, and irrespective of its size or legal form, when such an examination
is conducted with a view to expressing an opinion thereon. The person conducting this
task should take care to ensure that financial statements would not mislead anybody.
As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit
of financial statements, the overall objectives of the auditor are to obtain reasonable
assurance about whether the financial statements as a whole are free from material
misstatement and to report on the financial statements. The auditor should get the
scope of his duties and responsibilities defined by obtaining instructions in writ¬ing.
The chief utility of audit lies in reliable financial statements on the basis of which the
state of affairs may be easy to understand. The auditor is not expected to, and cannot,
reduce audit risk to zero and cannot therefore obtain absolute assurance that the
financial statements are free from material misstatement due to fraud or error. This is
because there are inherent limitations of an audit.
A significant step has been taken aimed at bringing in the desired transparency in
the working of the Auditing and Assurance Standards Board, through participation
of representatives of various segments of the society and interest groups, such as,
regulators, industry and academics.
The auditor shall comply with relevant ethical requirements including those pertaining
to independence. Relevant ethical requirements ordinarily comprise the Code of Ethics
for Professional Accountants (IESBA Code) related to an audit of financial statements.
The Code establishes the five fundamental principles of professional ethics relevant
to the auditor when conducting an audit of financial statements. (a) Integrity; (b)
Objectivity; (c)Professional competence and due care; (d) Confidentiality; and (e)
Professional behavior.
(b) Independence
(c) Confidentiality
(d) Integrity
Correct / Incorrect
State with reasons (in short) whether the following statements are correct or
incorrect:
(i) The basic objective of audit does not change with reference to nature, size or
form of an entity
(ii) The purpose of an audit is to enhance the degree of confidence of intended users
in the
e financial statements.
(iii) The auditor
uditor a cannot, reduce audit risk to zero and cannot
ditor is not expected to, an
and
therefore
efore
fore assurance that the financial statements are free from
ore obtain absolute assura
assuran
material
erial
rial fra or error.
al misstatement due to frau
fraud
(iv) The audit
udit sent by the client to auditor.
dit engagement letter is se
sen
(v) Specifi
ifi
fic disclosure is required ofof the fundamental accounting assumptions
assumption
p
followed
wed
ed in th
the
e financial statements.
nancial stateme
statement
statemen
statem tss.
Theoretical
ca
all Questions
Questions
1. Explain
ain
in Auditing.
n clearly meaning of Aud
Auditin
Audit g.. How
ow wou
would you as an auditor
di perform
p f the
audit.
t..
2. “The independent
ndependent
dependent
depen entity’s
dent audit of an en
ent
e tity’s
ity’s nancia statements is a vital service to
ty’ss financial
investors,
s, trade
stors,
tors,
ors, payables,
trade pay other
ables, and o
othe
otherr participants
articipants
rticipants exchange.”” Explain
ticipant in economic exchange Expla
3. State
e the
he objectives of Audit according
acco
accor
accord
d ng to SA 200
di
4. “The Code of Ethics for Professional
all Accountants, prepared by the International
Internation
Internationa
Federation of Accountants (IFAC) identifi
dentifi
de ifies five types off threats.”
h ” Explain
E l i
ANSWERS/SOLUTIONS
RS/SOLUTIONS
S/SOLUTIONS
/SOLUTIONS
Answers to MCQs
1. (a) 2. (b) 3. (c) 4. (d) 5. (b)
Answers to Correct/Incorrect
(i) Correct: An audit is an independent examination of financial information of any
entity, whether profit oriented or not, and irrespective of its size or legal form,
when such an examination is conducted with a view to expressing an opinion
thereon. It is clear that the basic objective of auditing, i.e., expression of opinion
on financial statements does not change with reference to nature, size or form of
an entity.
© The Institute of Chartered Accountants of India
1.36 AUDITING AND ASSURANCE
(ii) Correct: As per SA 200 “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”, the purpose
of an audit is to enhance the degree of confidence of intended users in the
financial statements. This is achieved by the expression of an opinion by the
auditor on whether the financial statements are prepared, in all material respects,
in accordance with an applicable financial reporting framework.
(iii) Correct: As per SA 200 “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”, the auditor
is not expected to, and cannot, reduce audit risk to zero and cannot therefore
obtain absolute assurance that the financial statements are free from material
misstatement due to fraud or error. This is because there are inherent limitations
of an audit, which result in most of the audit evidence on which the auditor
draws conclusions and bases the auditor’s opinion being persuasive rather than
conclusive.
conclusive
l i
(iv)
v) Incorrect: As per SA 21
((iv 210
2 10 “Agreeing the Terms of Audit Engagements”,the Audit
engagement letter is ssent
en by the auditor to his client.
(v)
(v Incorrect as per AS 1
Incorrect, 1,, ““Disclosure of Accounting Policies”, specific disclosure of
the fundamental acco
accounting
un assumption is required if they are not followed in
the financial statements.
statementtss.
Answers
Answers
swers to Theoretical Questions
Theoretical Q ue
estions
stions
1.
1. Refer
R fer 1:
Ref 1 Meani
M
Meaning
i g and
dDDefi
De
efi nition of Auditing.
finition g
2.
2. Auditing along with ot
Auditing other
o her disciplines
her scipline suchch as accounting and law, law equips
e
eq you
with
wit h all tthe knowledge
he kn
knowledg
owled e that hatt is requir
requi
require
required to e enter
te into
to aud t g as a profession.
auditing p
No busin
business
ess or institution
o institut on can
instit tion ann effectively
ect
ectiv carry on it
its activities
ti iti withou
witho
without
ith the help
of p
proper
roper reco
records
ds an
and a accounts,
acccounts,
counts,
unts,
nts, sinc nsactions take place at different
since transactions ere points
e
er
of time
t me wwith
ith nu
numerous
mero s persons
persons
ons and deen
entities. transactions
ies. The effect of all transacti
transact
transactio
transa has to
suitably
be recorded and suitabl
suitabblyy analysed
alysed to see the results as regards the business
bus
bu as a
whole.
h l P Periodical
i di l statements
t t ents nts of account are drawn up p to measure the success
s or
failure of the activities in n achieving organisation. This
hieving the objective of the organisation T would
be impossible without a systematic record of transactions. Financial statements sst
are often the basis for decision i i making
ki b
by th
the managementt and d ffor corrective
action so as to even closing down the organisation or a part of it. All this would be
possible only if the statements are reliable; decisions based on wrong accounting
statements may prove very harmful or even fatal to the business. For example, if
the business has really earned a profit but because of wrong accounting, the annual
accounts show a loss, the proprietor may take the decision to sell the business
at a loss. Thus from the point of view of the management itself, authenticity of
financial statements is essential. It is more essential for those who have invested
their money in the business but cannot take part in its management, for example,
shareholders in a company, such persons certainly need an assurance that the
annual statements of accounts sent to them are fully reliable. It is auditing which
© The Institute of Chartered Accountants of India
NATURE, OBJECTIVE AND SCOPE OF AUDIT 1.37